Have you noticed a growth spurt in your state tax bill? Is it
consuming more and more of your company's revenue? If so, the
good news is there are steps you can take to gain control of this
often overlooked tax liability.

State taxes are taking a bigger bite out of small-business
owners' bottom lines, and this trend is expected to continue.
As Washington moves more responsibility for funding social programs
to the states, the drive is on to collect more tax revenue at the
state level.

"If the federal government is going to contribute less,
then the states must contribute more because the money must come
from somewhere," says state and local tax specialist Michael
H. Lippman, a Washington, DC, partner with accounting firm KPMG
Peat Marwick LLP.

Entrepreneurs are already feeling the pinch. A recent survey of
the fastest-growing U.S. companies by accounting and consulting
firm Coopers & Lybrand LLP found state and local taxes were the
fastest-growing tax burden for these firms. Those surveyed reported
a 15.3 percent increase in state and local taxes in the past
year.

While most states are not actually increasing corporate or sales
tax rates, they are taking less obvious steps to expand their tax
base. One strategy, for example, is to subject more services to a
state's sales tax, says Sally Adams, an attorney and state tax
analyst for CCH Inc., a major provider of tax information in
Riverwoods, Illinois.

State governments are also making the tax rules even harder to
comprehend, and enforcement efforts are gaining greater muscle,
says Joe Donovan, a multistate tax services principal with Coopers
& Lybrand in Boston. To boost compliance, Donovan says, many
states have opened audit offices in other states, established
information exchange agreements among themselves and with the
federal government, and refined their strategies for tracking down
companies they believe aren't paying the correct amount of
taxes.

To collect more revenue, a number of states have expanded their
auditing activities, increasing staff by 20 percent to 25 percent,
says Jack Cronin, national director of Deloitte & Touche
LLP's state and local tax practice. This is a direct benefit to
state coffers, he explains, because auditors can generate revenue
that would not otherwise be available.

With all this activity directed at getting more tax dollars from
you, proper tax planning and a good understanding of state tax
regulations are essential. Accountants who specialize in state and
local tax issues suggest taking six important steps to put your
business in a better tax position.

1. Be sure to collect sales and use tax, not just in your
home state, but in the other states where you sell.
"Typically, companies collect these taxes in their home state,
but they may fail to collect them in the other states where they
have customers whom they reach through a local sales force,"
Donovan says.

States are looking for businesses that neglect to collect these
taxes, and companies that come to the attention of state revenue
collectors will be required to pay back taxes, as well as interest
and penalties. The message here is clear: Don't turn your
customers' tax liabilities into your own.

2. Consider doing business in more than one state. (This
won't help you if you are conducting business in a state that
doesn't have a corporate income tax, such as Nevada.) In many
cases, becoming a multistate business can reduce overall taxes,
says Lippman. Here's how it works: "If you are taxable in
only one state, you must report 100 percent of your income to that
state. But if your business is taxable in more than one state, then
you can apportion the income and the tax between the states, using
a special formula," he explains. "This could result in
income that doesn't get taxed in either state."
Establishing a business presence in another state can be as easy as
having inventory or a single salesperson in a rented office
there.

But before undertaking such a move, it is important to check
with a state tax specialist who understands each state's rules
to make sure it will result in a lower state tax bill.

3. Don't make the mistake of thinking you don't owe
any state or local taxes if you have a new company operating at a
loss. Although you may not have any state income tax liability,
your sales and use tax exposure continues to accrue if you fail to
collect and remit these taxes. Getting stuck paying a sales tax of
5 percent to 10 percent of your gross receipts yourself because you
didn't collect it from your customers can turn out to be a
significant amount, Donovan says.

Keep in mind that state corporate income taxes account for only
about 10 percent of a company's state and local tax burden.
State and local property and sales and use taxes make up the bulk
of your tax responsibility at this level. If you haven't been
collecting these taxes properly, many states will allow you to
negotiate a settlement. This often involves using the services of
your accountant. In this kind of give and take, states have been
known to waive penalties and a percentage of the taxes owed.

4. Stay abreast of details concerning the tax incentives,
exemptions and credits state governments offer to reduce a
company's tax bill. Small to midsized companies are often
eligible for such benefits, but many overlook them. In a number of
states, items used in manufacturing or in research and development,
for example, may qualify for such exemptions and credits.

"Competition among states to attract new businesses is
growing," says Cronin, "and states are offering property
tax abatement, job and investment tax credits, and manufacturing
equipment exemption credits." In some cases, these benefits
are also offered to encourage companies to continue operating
within a given state.

"There is a myth out there that only large companies can
land these tax benefits," says Lippman. "But states are
offering all types and sizes of companies benefits for either
locating facilities in a given state or moving headquarters into
those states."

In Massachusetts, for example, there is a program designed to
generate business development and new jobs, which may be activated
if your company establishes just one new job in a location dubbed
an "economic target area." "If your company meets
the requirement," says Donovan, "you are eligible for
special financing or credits that apply to the acquisition of
property."

Major accounting firms' state and local branches can
identify exemptions and credits for small companies. In addition,
every state and most major cities have economic development
councils that provide low-cost assistance in determining the tax
incentives that apply to your business.

5. Minimize unemployment taxes by making sure former
employees collecting unemployment benefits are actually eligible to
do so. "Very often when employees leave a company, they
claim unemployment tax benefits, even though they were discharged
or leave on their own accord," explains Lippman.
"Employers should document the reason for termination and then
actually go to the unemployment office and provide proper
documentation to substantiate it." This way, only individuals
who are truly eligible receive the benefits, and a tax charge is
not made against your account. "This is often overlooked, but
it's a very easy way to minimize unemployment taxes."

6. Keep track of your firm's personal property and its
worth. The personal property you report as yours should
actually be something you own. If you have scrapped a piece of
equipment, for example, eliminate it from your personal property
total.

Remember, there are three different types of property that can
be taxed: real property, which is made up of land and any
improvements to land; tangible personal property, which can include
business personal property, inventory, supplies, machinery and
equipment; and intangible personal property, such as stocks, bonds,
mortgages and intellectual property.

While there is no way to eliminate the tax man's bite
entirely, following these six steps can put your business on the
road to substantial savings on your state and local tax bill.

Getting Tough

Even with all the IRS' recent efforts to clarify the
controversial issue of independent contractors (including the
amnesty program we mentioned in the January "Tax Talk"
column), some courts are getting tougher in their rulings. For
example, a recent decision by the U.S. Court of Appeals for the
Ninth Circuit reversed a lower court's ruling and found that
hundreds of independent contractors working for Microsoft Corp.
were regular employees and thus eligible to participate in the
company's 401(k) and stock purchase plans.

In light of this trend, more companies are shying away from
independent contractors and instead are using employment agencies
or professional employer organizations. By going this route, a
company can sidestep the tax and legal problems associated with
independent contractors because these agencies put workers on their
own payrolls, pay the appropriate taxes, and do all the
paperwork.

If you are concerned about the independent contractor issue, you
may want to look more closely at employment agencies or employee
leasing options to avoid potential tax snags.